Question

Suppose the risk-free rate is 2.68% and an analyst assumes a market risk premium of 7.68%. Firm A just paid a dividend of $1.49 per share. The analyst estimates the β of Firm A to be 1.43 and estimates the dividend growth rate to be 4.21% forever. Firm A has 287.00 million shares outstanding. Firm B just paid a dividend of $1.85 per share. The analyst estimates the β of Firm B to be 0.71 and believes that dividends will grow at 2.46% forever. Firm B has 200.00 million shares outstanding. What is the value of Firm A? SHOW CALCULATIONS AND EQUATIONS

Answer 1

Value of Firm A

Step-1, Calculation of Required Rate of Return (Ke)

As per CAPM Approach, The Required Rate of Return (KE) is calculated as follows

Required Rate of Return (Ke) = Risk-free Rate + (Beta x Market Risk Premium)

= 2.68% + (1.43 x 7.68%)

= 2.68% + 10.98%

= 13.66%

Step-2, Calculation of the Current Stock Price (P0)

As per Dividend Discount Model (DDM), the share price is calculated as follows

Current Share Price (P0) = D0(1 + g) / (Ke – g)

= $1.49(1 + 0.0421) / (0.1366 – 0.0421)

= $1.55 / 0.0945

= $16.43 per share

Step-3, Value of Firm A

Value of Firm = Number of shares outstanding x Current price per share

= 287 Million Shares x $16.43 per share

= $4,715.41 Million

“Therefore, the Value of Firm A would be $4,715.41 Million”